Firms of a feather flock together - to benefit economic development

Dec. 12, 2007 -- In the quest for economic development, nearly every municipality determines its growth will come from attracting or building specific industries. Whether the industry is biotechnology, nanotechnology or computer science, the goal of cultivating multiple firms within a given municipality is a relatively common tactic. The question is: Should a community hang its hat on the agglomeration strategy?

"High-tech firms locating close to each other benefit from the proximity," says Barak S. Aharonson, visiting assistant professor of organization and strategy at the Olin Business School at Washington University in St. Louis. "The potential for frequent face-to-face interaction, serendipitous encounters and easy scrutiny are facilitated by being near firms that are working on similar things and are open to sharing information."

Coffee shop encounters could lead to new business ideas.

These "knowledge spillovers" happen more frequently the closer firms are to each other, and dissipate as the distance between companies grows. In fact, Aharonson said, the benefits of agglomeration are strongest within 500 meters (about 0.31 miles) and fade quickly over distances.

"Eventually they are all going to meet in the nearby coffee shop. The basis of agglomerations and the benefit for high tech firms is the flow of knowledge," Aharonson said. "At this point high tech knowledge is almost a public commodity. You can protect it, however through interactions with people — especially those outside the company — it disseminates rapidly. Proximity facilitates face to face interaction and increases the likelihood for knowledge spillovers. These knowledge spillovers enhance the potential creativity of the scientists. Increased creativity leads to new ideas, new products and new businesses. Hence, closely located firms are more likely to benefit from such knowledge spillovers than isolated firms."

Entrepreneurs strategically locate based on what resources are within 500 meters. Through research, Aharonson and colleagues, Joel A.C. Baum at the Rotman School of Management, University of Toronto and Maryann P. Feldman from the Institute of Higher Education, University of Georgia, found that companies choose to locate within a half-kilometer radius of essential resources such as research and development activity, labor and capital. The researchers looked at the availability of resources at greater distances and found that after 10 km, the influence of access to the resources diminishes.

For cities that seek to foster economic growth through an accumulation of businesses, Aharonson points to several ways to make it happen.

"There's a lot to take into consideration if you want to facilitate growth in a certain industry," Aharonson said. "You have to make sure firms have access to resources throughout the value chain. That means having a flow of ideas from local public research institutions such as universities and hospitals to facilitate new entrepreneurial activity. It also means having a skilled labor force from universities and leading local pharmaceuticals so it is easy for growing firms to hire people. And it means having physical space that can facilitate interactions."

Communities can provide more traditional incentives in other forms, of course. But, Aharonson said, the biggest lure for attracting entrepreneurial firms is having these ingredients in a close proximity.

Editor's note: Professor Aharonson is available for live or taped broadcast-quality interviews using Washington University's free VYVX or ISDN lines. Please contact Shula Neuman at (314) 935-5202 for assistance.